How do you calculate variable rates?

A:

Quick Answer

Variable interest rates are actually two rates added together. The first is a fixed rate called "margin" that is based on the credit worthiness of the borrower. The second rate varies and is tied to the movement of a specified index as stipulated in the loan contract.

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Begin by referencing the loan contract. It should state the margin rate as well as the index being used to determine the variable index rate. The contract may also stipulate a floor or ceiling level that prevents the rate from moving beyond certain levels.

Next, look up the appropriate rate index on the Internet. The prime rate is the most commonly used index. Rates that are not based on the prime rate are often based on the London Inter Bank Offer Rate, or LIBOR, or various U.S. Treasury bill and note rates. These rates may fluctuate based on economic conditions, so it's important to reference timely data.

In order to calculate the actual loan annual percentage rate, add the fixed margin rate to the index rate. For example, if the fixed rate of the loan is 7 percent and the index rate is 3 percent, then the annual percentage rate for the loan is 10 percent.